ECON 102.004 – Principles of
Microeconomics
Introduction and S&W, Chapter 1
Instructor:
Mehmet S. Tosun, Ph.D.
Department of Economics
University of Nevada, Reno
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Microeconomics is the study of decisions
made by individuals, firms and government
and how those decisions determine prices in
the market.
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Five Core Ideas
• Trade-offs: scarcity of resources, no free
lunch
• Incentives: benefits that motivate a decision
• Exchange: voluntary exchange in markets
lead to efficient use of resources
• Information: informed choices require
information
• Distribution: how markets distribute wealth
matters
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Trade-offs
• All choices involve trade-offs:
– What should you spend your weekly budget
on—pizza, CDs, movies, books, and so on?
• More of one of these means you can spend less on
another.
• There is no such thing as a free lunch.
• Trade-offs stem from scarcity.
– You have limited money and time.
– Society has limited resources.
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Incentives
• Incentives are the rewards and costs that
stem from making choices.
– Prices reflect incentives: rewards and costs.
– All decision makers, consumers, businesses,
and governments respond to incentives.
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Example: Superstar Economics!!!
• Was it a good idea for Viacom to let Tom
Cruise go?
• Does a superstar guarantee success?
• Do you see a movie for its cast?
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Exchange
• Exchange is the trade of goods and services.
• Voluntary exchange in markets is how modern economies like
the United States determine which goods and services to
produce to satisfy the vast number of consumers.
• Voluntary exchange means both parties get something they
want; a worker wants income and a firm wants a certain job
done, for example.
• A market is any situation in which an exchange takes place.
– A market need not be a physical location.
– With competition, consumers have a choice of alternatives.
– The United States is a mixed economy where most
exchanges take place in a market but the government plays
a critical role in other aspects of the economy.
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Information
• Making informed choices requires information.
• Information is like any other good or service.
– There are firms and institutions that specialize in the
purchase and sale of information.
– The seller of a car lets you test drive it, but a seller of
information cannot let you see the information.
• In some markets information is so crucial it shapes
the whole market:
– Market for used cars
– Stock market and other security markets
– Insurance
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Distribution
• Markets determine who gets which goods
according to the demand and supply of goods,
labor, and capital.
• Some view the uneven distribution of wealth
with unease.
• Government programs attempt to even out the
distribution.
– However, efforts to soften the distributional impact
of markets often blunt economic incentives.
• That is, there is a trade-off between equity and
efficiency.
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The Three Major Markets
• The product market: where final goods and
services are exchanged
• The labor market: where workers sell labor
and firms hire workers
• The capital market: where households,
firms, and government save and raise funds
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The Three Major Markets
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Microeconomics and Macroeconomics
• Two branches of Economics:
microeconomics and macroeconomics
• Macroeconomics (study of the large) studies
behavior of the whole economy or
aggregates like
– Inflation
– Unemployment
– Output
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From NYT
Macroeconomic Issues:
“The American economy grew more quickly in the
second quarter than the government had initially
estimated, and inflation was slightly lower, the
Commerce Department reported today.”
“The gross domestic product, a measure of all goods
and services produced in the United States,
increased at an annual rate of 2.9 percent, up from
an earlier estimate of 2.5 percent, while a closely
watched measure of prices that excludes food and
energy rose 2.8 percent, rather than 2.9 percent.”
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• Microeconomics (study of the small) studies
how people make decisions
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The Science of Economics
• Economics is a social science.
– Economic theory is composed of:
• Assumptions or hypotheses and the conclusions
derived from them.
• Theories are logical exercises that lead from
assumptions to conclusions.
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Economic Modeling
• Economists use models to test theories.
• Models are abstractions.
– They are oversimplified to stress the essentials of
a complex social reality.
• Engineers do not put the "Fasten Seat Belts" sign on a
model of an airliner to test it in a wind tunnel for
aerodynamics.
– Economists use the theory of perfect competition
even where it only holds approximately.
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Discovering and Interpreting
Relationships
• Economists seek to understand the
relationships among economic variables
that can be measured and may change.
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Causation and Correlation
• Correlation – when one variable changes another
tends to change.
• Causation – when changing one variable “causes”
another variable to change then changing the first
necessarily changes the second.
– In the 1970s imports of cars from Japan rose while U.S.
auto production fell
• These variables are correlated, but was there causation?
• No; both events were related to a third event:
– Higher oil prices pushed U.S. consumers away from “gasguzzling” U.S. cars toward more fuel efficient Japanese
cars.
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Example: Migratory Birds and Inflation
• When birds migrate south in winter,
inflation gets higher
• Does bird migration cause higher inflation?
• Correlation does not mean causation
• What is the third external factor here?
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Why Economists Disagree
• Economists often disagree about public policy.
• Their differences usually fall into one of two categories.
– Positive Economics: differences about how the economy
operates
• These differences stem from differences over which model
to use.
– Normative Economics: differences about how to evaluate
the consequences of policies
• These differences stem from different assessments of the
quantitative magnitudes of the analysis.
– Economists have different values which may lead them to
disagree about policies.
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